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Sales or Income: Which State Tax Revenue Is Best?

A debate is brewing across several U.S. states regarding the best way to collect state tax revenue. No one likes taxes, but states typically turn to taxation to pay for road repair and maintenance, education, law enforcement, fire protection, corrections, parks and recreation, and government administration, among other public services. The 50 states differ in how they tax residents, however. For instance, seven states have no income tax, while two tax only income from interest and dividends (Tennessee and New Hampshire). The remaining 41 impose personal income tax, but some are questioning whether to ditch this practice.

The Struggle to Shift State Tax Burdens

Several of those 41 states are considering shifting the tax burden from income to sales taxes. As “Wealth of States” points out, sales tax has the least negative impact on state economic growth (p. 87). In fact, a 10-year study of the nine states with the highest sales tax rates reveals that they are outperforming the nine states with the lowest sales tax rates—the complete opposite effect of high income taxes.

Eliminating the Income Tax

Maine Gov. Paul LePage is pushing for his state to become the 10th in the nation without an income tax. The Republican state leader has proposed an amendment to the state’s constitution that would prohibit a state income tax. Under LePage’s plan, the change from income tax to sales tax would be complete by 2020.

LePage wants to make Maine, which neighbors tax-friendly New Hampshire, more competitive for businesses and retirees while not hurting state tax revenue.

Politicians in Virginia are also looking to eliminate the state’s income tax. Vince Haley, a Newt Gingrich policy aide who ran for Senate earlier this year, believes Virginia can phase out the income tax by funding the state’s liabilities and maintaining economic growth through more controlled, responsible spending and targeted budget cuts.

Sales Tax: The Lesser of Two Evils?

Most states working toward eliminating their income taxes are considering sales-tax increases to fill the budget gap. This will be easier for states that already have a low income-tax burden. However, states such as Oregon, which does not charge sales tax and takes 74 percent of its tax revenue from income, could have a hard time making up the difference from sales taxes alone.

Which of the 41 states will become the next income-tax-free place in which to work and live? Each state legislature proposing this huge change requires a three-fourths approval to make it to the governor’s desk for signature. The shift won’t happen overnight, but the sooner it does, the sooner Americans can begin capitalizing on new revenue in their pockets.